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In its November ruling, the Court of Appeal considered whether a fresh issuance of shares by directors which altered the balance of voting power between the shareholders was done for a proper purpose.

Background

The rationale behind the 'proper purpose' rule is that directors should not issue shares in a manner that could affect the balance of power between groups of shareholders in the company or create new majorities, as happened in this case. The directors created a new majority by way of the July issuance and, for the proper purpose rule, it does not matter whether the old or new majority had a proprietary interest in the fund.

Decision

The basic rule is that the directors' purpose, however noble, should not be used to affect the balance of power in the company. If it is used in this way, it is considered an improper use of power and is liable to be set aside. However altruistic the motives and reasons may have been, "that is not, in itself, enough". The court applied the leading case of Howard Smith Ltd v Ampol Petroleum Ltd ((1974) AC 82) and Sections 121 and 184B of the Business Companies Act 2004.

Where a power struggle occurs between different groups of shareholders, as happened in this case, the directors should not issue additional shares in such a way as to affect the balance of power in the company (or fund) to influence the outcome of shareholders' resolutions, even if this results in additional capital or other benefits for the company.

This restriction is not written into the company's articles of association and for this reason the law (equity) imposes on directors the additional requirement that the shares must be issued for a proper purpose. If the directors issue shares for an improper purpose, the issue is liable to be set aside. The fiduciary obligation to issue shares for a proper purpose was incorporated in Section 121 of the Business Companies Act, protected and enforced through Section 184B.

The directors' fiduciary duty to issue shares for a proper purpose is not minimised if the shares that are being issued have no proprietary interest in the company and are not being issued for the purpose of raising capital.

The ruling has implications for all corporate and funds clients, including directors and appointed officers.

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